In September or October coming the US Supreme Court must consider whether to issue a ruling on a dispute over Argentina’s foreign debt. Under existing rules various institutions have the right to file a ‘friend of the court brief’, taking a position on the matter in hand, which is submitted for consideration by the Justices. The International Monetary Fund (IMF) said it was considering filing a brief supporting Argentina’s position. So did the US government. Then White House sources said they wouldn’t be filing a brief after all. That caused the IMF to say that if the US wasn’t going to file, then it couldn’t possibly do so itself. At that point the French government said it was definitely filing. What’s going on?
This long-running and complex legal case derives some of its volatility from the mixture of legal, financial and political interests at play. Its origins lie in Argentina’s 2001/2002 default on over US$100bn of foreign debt. As debt service payments stopped, the market value of Argentine debt paper collapsed. As part of complex rescheduling negotiations in subsequent years a majority of creditors eventually accepted a ‘haircut’ – a debt-swap deal whereby they received new bonds worth roughly 33% of the old debt’s face value. But a minority of bondholders refused to accept the deal.
Some of these bonds had been bought at massive discounts by hedge funds opportunistically seeking to demand payment in full at a later date (this earned them the nick-name of ‘vulture funds’ in Argentina). For the better part of a decade, these ‘holdouts’ lost most of their legal battles, but in November 2012 US Federal Judge Thomas Griesa, citing a clause in the debt contracts requiring equality of treatment for all creditors (the ‘pari passu’ clause), ruled that Argentina had to pay the holdouts a total of US$1.33bn. Argentina then lodged a series of challenges against the Griesa ruling at the Court of Appeals and the Supreme Court. Many of these were rejected, but the Supreme Court is expected to consider whether to hear the case after its summer break.
While both the IMF and the US have a series of disagreements with Argentina over its economic policies and over other issues, initially the reason to file a supportive ‘friend of the court’ brief seemed very clear. Argentina’s was neither the first nor the last sovereign default. Fresh from the near-collapse of the Greek economy, and to bolster the international financial system, the IMF and its member governments desperately need an orderly way of rescheduling debt, including the ability to enforce creditor ‘haircuts’ where necessary. If the Griesa ruling stands, giving the holdouts payment in full, then it is argued that other creditors will lose the incentive to share the pain of a rescheduling. All creditors could become holdouts, blocking debt renegotiations entirely, and increasing the risk of systemic financial failure.
The White House has not fully explained its change of heart. The US Treasury says it remains concerned that the existing ruling “will undermine the orderliness and predictability of the sovereign debt restructuring process”. One reason not to file may be technical: the case remains pending at the Appeals Court level and is not yet formally being reviewed by the Supreme Court.
Another may be political. The holdouts, which include prominent US Republican Party funders, are represented by a lobby group, the American Task Force Argentina (AFTA), which has been conducting an aggressive PR campaign stressing Argentina’s links with Iran. The Barack Obama administration may not want to take the political heat of appearing to support Argentina at this point.
In addition there is an argument that says a judgement against Argentina might paradoxically do more to solve the systemic problem facing the global financial system than one in Argentina’s favour. Various analysts believe that by creating an untenable situation, this would force sovereign borrowers and their lenders in future to agree to sign collective action clauses (CACs), which would establish for example that a restructuring agreed by a certain proportion of creditors – say 75% – would be legally binding on all of them. In a recent opinion piece in the UK’s Financial Times, Aldo Caliari of Colombia University and José Antonio Ocampo, a former Colombian finance minister, put their case as follows: “We believe a formal international framework for debt restructuring is needed. A decision against Argentina will make the negotiation of such a mechanism inevitable”.
All this leaves Argentina in a very uncomfortable place. Over a decade after it defaulted on US$100bn, a dispute over the much smaller amount of US$1.3bn could again, in the worst-case scenario, push the country back into technical default.
If the Griesa ruling is upheld and the government led by President Cristina Fernández agrees to pay the US$1.3bn, it will be seen as a massive and politically damaging climb-down by a leader who for years has condemned the vulture funds and the international financial system. With congressional elections due in October, this will be an extremely unattractive scenario for the Buenos Aires government. If on the other hand the ruling is upheld and Argentina refuses to pay, then the US courts could ultimately inhibit payments from Argentina made through the US funds transfer system to the other creditors that accepted the restructurings. Estimates made last year suggest that this would be equivalent to triggering a technical default on around US$24bn worth of debt issued in the 2005-2010 restructurings. The least damaging option for Argentina is of course the one in which the Supreme Court overturns the Griesa ruling and the sovereign borrower doesn’t have to pay a politically damaging US$1.3bn. At the moment France is the only ‘friend of the court’ who is formally favouring that outcome.
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